Asset managers worried about increased federal oversight of nonbanks

The asset management industry is worried about the impact of new guidance from the Financial Stability Oversight Council that eases FSOC's ability to designate nonbank financial institutions as systemically important and place them under Federal Reserve supervision.

"Generally speaking, the idea that our industry — alternative asset management — is a financial stability risk is something that we are fundamentally opposed to and think is deeply flawed," said Jillien Flores, head of global government affairs at the Managed Funds Association.

FSOC finalized the guidance, originally proposed in April, on Nov. 3 in tandem with a new framework for identifying, assessing and addressing risks to financial stability. The guidance will replace previous guidance promulgated under the Trump administration in 2019 that relied on exhausting all alternatives before moving to designate a nonbank as a systemically important financial institution, or SIFI.

The alternatives included what is known as an "activities-based approach" for addressing risk in the financial system, meaning that FSOC often worked with other federal and state regulators to determine certain activities that might pose risks and took action to adequately address them. FSOC also would conduct a cost-benefit analysis and assess a company's likelihood of material financial distress before turning to a SIFI designation under the previous guidance.

Under the new guidance, these steps will no longer be used, as FSOC determined they are "not legally required, are not useful or appropriate, and would unduly hamper the council's ability to use the statutory designation authority in relevant circumstances," the final guidance states.

But many in the asset management industry say those previous guardrails in place were necessary, and the move toward easing a SIFI designation was uncalled for. Financial firms want to avoid the SIFI designation because it comes with added regulatory scrutiny and heightened compliance costs.

"It is disappointing that FSOC has decided to adopt a flawed risk assessment framework and a designation guidance that backtracks from current standards," said Eric Pan, president and CEO of the Investment Company Institute, in a statement. "The move away from an activities-based approach and towards making it easier to label a company as 'systemically important' lacks justification."

MFA's Flores agreed that an activities-based approach is "a much more common-sense approach" to addressing financial stability concerns in the non-banking sector.

"The final framework invites less analytical rigor in FSOC's examinations of potential risks to financial stability from financial activities, products or practices," Pan added. "For example, the move away from conducting a cost-benefit analysis does not lend itself to thoughtful decision-making based on empirical evidence."

Under the new process, FSOC will determine a SIFI designation through "a preliminary analysis, based on quantitative and qualitative information," provided mostly through public and regulatory sources, and give selected companies a chance to respond, according to a Treasury Department news release. The council also has some "mandatory considerations" that it must consider for a SIFI designation, including "a company's leverage, off-balance-sheet exposures, and importance as a source of credit," the final guidance states.

If FSOC moves forward with its process, the company would then discuss the matter with its primary regulator and FSOC, and an official designation requires a two-thirds vote from FSOC's 10 voting members. Those voting members include Treasury Secretary Janet L. Yellen, who chairs the council; Federal Reserve Chair Jerome Powell; SEC Chair Gary Gensler; and Rostin Behnam, chair of the Commodity Futures Trading Commission.

Flores said that unlike the risks associated with banks taking depositor money, alternative asset managers take investment risks based on institutional investors' individualized priorities and objectives, so "there really is not a way for that risk to transfer into the broader financial system."

And according to Casey Jennings, counsel at law firm Seward & Kissel and a member of its financial services regulatory group, the new guidance could have unintended consequences."Designating certain asset managers as SIFIs could boomerang," Jennings said in a statement. "The market could recognize a SIFI designation as a too-big-to-fail badge, causing distortions in risk assessments."

Flores also said the new SIFI designation process is not transparent, which will affect firms' futures.

"It really inhibits the ability for a company to plan its business over the course of however many years ahead … and think about acquisitions or new business lines or new offerings, not knowing how FSOC even determines which entities it may look at to consider (a SIFI) designation," she added. "It's a bit of a black box."

Jennings said in an interview that most asset managers are likely taking a "wait-and-see approach" to see how the new guidance will be applied.

"We can only hope that FSOC will resist the temptation to employ its SIFI designation authority without sufficient analysis of all relevant factors or consideration of alternatives," ICI's Pan said in his statement. "SIFI designation is a blunt tool that offers an outsized focus on individual companies rather than a holistic assessment of risk."